Quick Thoughts on Portfolio Rebalancing
What do I mean by rebalancing?
I think of rebalancing as the process of buying and selling assets to restore your desired asset (or individual stock) allocation.
You can think of rebalancing as akin to “shorting volatility” (selling calls and puts) to earn premiums and enhance return.
To rebalance, you’re selling the appreciated asset (equivalent to it being called) and buying the depreciated asset (as if it were put to you).
Why should you rebalance?
Well, empirical evidence has shown that disciplined rebalancing tends to reduce risk and enhance return.
You also should benefit from increased diversification, especially because riskier assets tend to rise in value and portfolio weight.
Rebalancing Methods:
1) Determine suitable ranges ahead of time for your asset weights and rebalance if things get out of whack.*
*I think the same applies for individual stocks, but you could base position size based on your conviction level, and rebalance if things get out of whack.
2) Simply rebalance on a regular calendar
basis (e.g., annually or quarterly). This method requires less attention, but does ignore interim fluctuations in value and risk exposure.
3) Use a percentile range. In this case, you’d rebalance if the devotion exceeds “X%” from your target. This method requires the most attention / monitoring, but is better at controlling risk.
Wider position ranges are more appropriate for:
1) Avoiding taxes (an important consideration - if you can avoid selling without a year, you’ll avoid avoid short-term capital gains taxes).
2) Investors w/ higher risk tolerance (this depends on the person, but if you can stomach the risk and have conviction, let winners run).
3) Higher correlation between stocks positions (e.g., if you’re only invested in high-growth SaaS companies, trimming winners may not decrease your overall portfolio risk much).
4) Higher volatility / momentum names (e.g., if you’re invested in high flying fintwit small cap names, you’re likely better off with wider ranges. Let your winners run and compound, if you expect them to keep winning of course.
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Would be curious to know - does anyone here rebalance their portfolio? If so, do you have a good system for doing so?
I personally find it tough to decide whether to trim winners! So, I end up simply sizing up my highest conviction names and cutting low ones.
- Jake
Great post Jake! Personally, no I do not “rebalance” per say, but I will close out of names I feel have hit their fair value. My strategy is also very different from most, as my risk tolerance is different too. I tend to let winners run, timeframe between 5-8 years.